What is robo advising? Your top questions answered
April 13, 2023
8 min read
What we'll cover
The ins and outs of robo advising
Average cost of robo advisors vs. human advisors
Benefits and risks of using a robo advisor
From smart homes to self-driving cars, technology has redefined the way we live. And robo advisors have changed the way we invest. They add the benefits of automation to your finances by helping you build and manage an investment portfolio with the help of technology.
But what is robo investing? And should you use a robo advisor? This guide will help you work through those questions and dispel some of the myths about this type of investment approach.
What is a robo advisor?
What is robo advising? More specifically, what is a robo advisor and how do they work?
In a nutshell, a robo advisor is an investment offering that combines human smarts with digital efficiency and convenience. It uses computer software and unique algorithms to build diversified portfolios for investors.
Instead of working one-on-one with a human investment advisor, robo advisors allow you to take a hands-off approach to investing and sometimes, avoid big fees at the same time.
How robo advisors work
Think using a robo advisor sounds intimidating?
It doesn’t have to be.
Here’s a quick look at what a robo advisor will do for you:
It’ll take you through a survey to ask about your investment goals, how much time you have to invest, your risk tolerance (how comfortable you feel risking your money) and how much money you already have saved.
An algorithm then recommends a diversified portfolio based on the input you’ve entered.
You can arrange for a robo advisor to automatically add contributions from your bank on a regular basis.
The robo advisor manages your portfolio. Some robo advisors, like Ally Invests Robo Portfolios, take investment management a step further and offer features like automatic rebalancing and portfolios designed for tax optimization. Rebalancing helps to keep your portfolio’s asset allocation in line with your goals by realigning how much weight your investments have. The tax optimized portfolio at Ally Invest utilizes tax-advantaged investments seeking to reduce your tax liabilities within the law.
Some robo advisors offer tax-loss harvesting. Tax-loss harvesting means that you sell some investments at a loss to offset gains you’ve achieved by selling other stocks at a profit. Doing so can help minimize the amount of tax you pay on capital gains in your portfolio. (Capital gains tax applies to profits earned on your investments.)
Portfolio building, robo advisor rebalancing, tax optimizing and tax loss harvesting are done using a combination of human input and technology to make the process as efficient as possible.
Many robo advisors build diversified portfolios that consist of exchange-traded funds (ETFs), which are low-cost funds that trade on an exchange like a stock. ETFs offer low expense ratios, which is the annual management fee you pay to own the fund. ETFs also may have lower turnover rates. This means that the assets within the fund aren't bought or sold regularly compared to traditional mutual funds. When fund turnover is low, fewer capital gains taxes will likely occur.
That’s something you want if you’re investing in a taxable brokerage account. Offering ETFs is one way robo advisors aim to keep investor portfolios as tax efficient as possible. When considering tax matters, we do recommend you consult with your tax advisor or other tax professional.
How much money do you need to invest using a robo advisor?
You don’t necessarily need a substantial amount of investable assets to start building a portfolio.
Some robo advisors expect you to have $5,000 or more to invest, but others have no minimum deposit requirements to open an account and start investing. At Ally Invest, you can open a robo portfolio with just $100.
Regardless of how much or how little you start with, robo advisors typically make it easy to add to your investments. You can link a bank account and set up recurring automatic transfers into your investment account to help your portfolio keep growing.
How much does robo advising cost?
Robo advisors generally charge far lower and far fewer fees for their services than human advisors. Instead of collecting a commission or trading fees and a management fee, robo advisors often charge a single fee to manage your account.
This fee could be a flat dollar amount or a percentage of investable assets in your account, charged monthly or yearly. The cost of using a typical robo advisor ranges from 0.2% to 0.5% of your account balance, compared to human portfolio managers, who may charge a 1% to 2% advisory fee for their services. In the case of Ally Invest, our cash enhanced Robo Portfolio has no advisory fees.
Can you trust robo advisors? Are they safe?
Robo advisors at reputable brokerages should come equipped with bank-grade security and fraud alert features. When deciding to open an account, it’s best to confirm the exact measures and safeguards the brokerage has in place to ensure your personal information will be protected.
In terms of your investing risk tolerance, robo advisors also offer another degree of safety and security: portfolio rebalancing.
The purpose of rebalancing is to help keep your portfolio in line with its diversified target allocation and your risk tolerance level. Diversification doesn’t eliminate investment risk, but rebalancing is designed to help your portfolio navigate the market ups and downs, so you don’t get over or under concentrated in any one sector.
Of course, you still want to monitor your portfolio yourself, too — don't just "set it and forget it." That goes for any investment you make!
What are the benefits of using a robo advisor?
There are several reasons to consider using a robo advisor and many of them can be traced back to one thing: convenience.
When you let a robo advisor choose your investments, it eliminates the headache of trying to create a diversified portfolio on your own. You don’t have to be a stock or investing expert to use a robo advisor. The platform uses the information you provide about risk tolerance and financial goals to present you with a balanced investment portfolio that aligns with your specific needs.
Besides that, robo advisors can also offer other tools to help you manage your investments, like access to retirement calculators or a library of financial planning-related articles.
What are the risks of using a robo advisor?
The biggest downside to a robo advisor is exactly what you might expect — you lose a slight human touch in the process of choosing investments and walking through your goals.
However, one misconception about robo advisors is that they’re completely digital — that’s not necessarily the case.
While computer software programs do some of the work when it comes to portfolio management, more comprehensive robo advisors, like Ally Invest’s, also employ human financial professionals to oversee portfolio recommendations.
How do you decide if a robo advisor is right for you?
Robo advisors may be better suited for some investors than others. To determine if using one is the right move, consider how much time and effort you can put into investing and what you hope to get in return.
If you’re new to investing and want to make building a portfolio as simple as possible, with minimal costs, then a robo advisor can help you do that. On the other hand, if you’d prefer more control over what goes into your portfolio, you might be better off with a Self-Directed Trading account instead. In this type of taxable account, you pick and choose which investments (stocks, bonds, ETFs, options, etc.) you’ll use to pursue wealth.
Is there any human element about a robo advisor?
Some robo advisors don't offer human help. However, Ally Invest does, to some extent, which makes robo advisors a hybrid that combines both worlds. You get the convenience of a technology-enabled process along with access to a human support team — but without any added costs.
Making the leap to robo investing
Think you’re ready to robo invest? Whether you’re looking to create a diversified portfolio through individual, joint, custodial, Traditional IRA, Roth IRA or rollover IRA account types, there are plenty of robo choices out there. At Ally Invest you can choose from a variety of portfolios, including the following:
Core: Highly diversified across domestic, international and fixed-income assets. You can choose the amount of risk you are comfortable with, from conservative to aggressive
Income: This portfolio type offers higher dividend yields while maintaining a more conservative risk profile
Tax optimized: If you make after-tax contributions to an investment account, this type of portfolio may help maximize your investments.
Socially responsible: You’ll invest in businesses that actively practice sustainability, energy efficiency, or other environmentally friendly initiatives
Robo investing offers a plethora of perks, including low fees, low initial investment requirements, and many investment choices.
Technology can make our lives easier, but it’s up to you whether or not you want to make it a part of your investment strategy. If you do, a robo advisor could be the solution you’re looking for.